Shares of leading cybersecurity pure-play Palo Alto Networks (PANW 0.91%) are up 35% so far in 2023. The company was a standout performer during the bear market, holding up well while other technology stocks were clobbered last year. Thank PANW's fast and consistent growth, and improving profit margins.
After the latest quarterly update, there's still a lot to like about Palo Alto Networks' long-term prospects. Here's why I remain a buyer of this top cybersecurity stock.
Another quarter of exceptional financial performance
A few days ahead of PANW's latest quarterly report, I highlighted how the company is using artificial intelligence and new cloud-based modules to help protect its customers in a fast-changing digital world. PANW didn't disappoint in its second-quarter fiscal 2023 update (the three months ended in January 2023). The company's annualized "next-gen security" (NGS) recurring revenue was $2.33 billion, up over 10% from last quarter and up 63% from a year ago.
On a quarterly basis, PANW total revenue (which includes NGS, as well as product sales and other legacy services) was $1.66 billion. That was a 26% year-over-year increase, and at the high end of guidance provided three months ago. Net income was $84.2 million (or $331.7 million on an adjusted basis), compared to a net loss of $93.5 million the same quarter last year. Earnings soared far beyond management's outlook as CEO Nikesh Arora and the top team's focus on more profitable growth begin to pay off.
With inflation and risk of recession on the business world's mind right now, tech spending has been slowing down. But PANW has been putting up consistent numbers. That's because cybersecurity is a top necessity as more organizations migrate to the cloud to try to unlock new operational efficiencies. However, to get more bang for their buck, businesses are turning to companies like PANW that can bundle many types of security together to help tighten up on cost (what the cybersecurity industry, including security software leader Microsoft (NASDAQ: MSFT), has been referring to as "vendor consolidation").
In light of the positive vibes it's been getting from customers, Arora and company issued an improved outlook for the second half of fiscal 2023 (the 12-month period that will end in July 2023). Total revenue is still expected to be in a range of $6.85 billion to $6.91 billion, representing 25% to 26% growth over last year. But the real upgrade came in profitability. Adjusted earnings per share are now expected to be in a range of $3.97 to $4.03, up from the previous guide for $3.37 to $3.44 before.
Buy the stock for all that free cash flow
Additionally, PANW upgraded its expected adjusted free cash flow margin to be 36.5% to 37.5% this fiscal year (previously 34.5% to 35.5%). That implies the company will generate about $2.55 billion in free cash flow this fiscal year, which compares to $1.83 billion in adjusted free cash flow in fiscal 2022.
This is significant as PANW makes steady progress in improving its GAAP net income margins (which include non-cash expenses like amortization of acquisitions of smaller security peers and employee stock-based compensation).
Specifically regarding stock-based compensation, PANW has shelled out $549 million worth of new stock to its employees in the first half of fiscal 2023. Stock-based comp is tied to long-term employment contracts, so it isn't easy to cut this expense down overnight. But just like it did last year, PANW plans on mostly offsetting this new stock by repurchasing shares on the market. Share repurchases were $273 million in the first half of this fiscal year, picking up pace again in the second quarter ($250 million) after a brief hiatus in Q1 (only $23 million).
The result? An impressive track record of free cash flow-per-share generation for shareholders the last three years.
Data by YCharts.
Palo Alto Networks now trades for just 20 times trailing 12-month free cash flow. If you believe this top cybersecurity company can continue to grow at a double-digit percentage over the next few years, this remains one of the best buys in the cybersecurity space right now.
